JenniferOpenshaw

Columnist

NEW YORK (MarketWatch) — Taxes are done and you may have moved a few thousand dollars into your retirement accounts. Now what?

It’s time to choose where to invest it. You can sift through the choices, or you can leave the driving to someone else.

Fairly new on the scene, some have been around for three years or less, target-date funds offer a packaged way to invest.

Target-date funds are special mutual funds that invest in other funds in their family according to a specific asset allocation deemed appropriate for someone of your age. That allocation adjusts automatically as you approach retirement.

So a 2040 target-date fund has more aggressive investments, suitable for someone with decades before retirement, while a 2015 retirement fund tends toward more conservative and fixed-income investments appropriate for someone retiring in seven years. Most fund families offer target-date funds in five- or 10-year increments from 2010 to 2050.

The advantages

• Autopilot for your investments. You don’t have to worry about asset allocation, and even better, you don’t have to worry about changing your asset allocation as you age. You can spend your weekends skiing and tending to the garden instead of poring over long lists of mutual funds in categories you know nothing about, like European stocks or high-yield bonds.
• Diversification for less. If you’re investing only $4,000 or $5,000 a year or less, you still get full diversification. Target funds have minimum investments as low as $100, most are $2,000 to $3,000. If you tried to create your own target fund, you might confront such minimums for each individual fund. Also, you might expect an onerous fee structure, since you’re paying for the target fund and the funds in which it invests. From my investigation, fortunately this isn’t the case. You’re getting the asset allocation offered by the target package for free.
• Safety. For retirement investments, safety is an advantage, although many consider it a disadvantage because returns often aren’t as high as many would like, even in the more aggressive mixes tailored to longer retirement horizons. The Schwab Target 2040 fund SWERX, -0.49% is down about 4.2% year-to-date, negative but still in the top 40% of its fund category.

The disadvantages

• Bland investments. To my surprise, the heralded Vanguard target-date fund family invests solely in its own index funds. That’s good for fees (only 0.21%) but doesn’t expand the girth on your nest egg. The aforementioned Schwab Target 2040 fund is one of the more ambitious, actively-managed funds, but brought a 2007 return of 3.6% — putting it in the bottom 25% among its peers. Upshot: you won’t get rich owning target funds.
• Diversification question. Unfortunately, most target funds invest only in funds from that fund’s family — Fidelity, Vanguard, etc. That blunts diversification, and you’re locked into one company’s mindset.
• Potential for bad timing. Some asset classes may be untimely for new investments. While target funds usually include asset classes like bonds, REITs, and international stocks, on the whole those asset classes may be high priced or otherwise unattractive right now. Beware, especially if you’re buying when your target date is near.

What to do

• Study their investments. If the target-date fund invests in index funds, that’s fine if you want index funds. The Vanguard Target Retirement 2040 fund VFORX, -0.56% has five index funds. But other target-date funds, such as those from Schwab, have many more funds and all are actively managed, a fairly eclectic mix. The Schwab Target 2040 fund has 10 different actively managed funds. The fees are higher (0.96% in total) but that’s not bad for the diverse and active mix.
• Understand the mix. Equity means different things to different funds. The Vanguard Target Retirement 2030 fund VTHRX, -0.47% is 90% equity. Digging deeper, 18% of the 90% is international. T. Rowe Price’s Retirement 2035 fund TRRJX, +1.07% has 94% equity but only 6% of that is international.
• Find out whether allocations are fixed. Allocation plans may be subject to change without notice. Vanguard locks their allocations from the beginning, but other funds may tinker with percentages, beyond what time alone would suggest, to boost returns. So you may not be getting what you think you’re getting. Read the prospectus — or better, talk to one of the agents. Incidentally, agents I talked to at Vanguard, Schwab and T. Rowe Price were well trained and helpful. It’s worth the time if you’re seriously considering this path.
• Focus on the target fund. Most experts advise going all target if you’re going any target — otherwise, you risk running afoul of the intended allocation.

As with most investing, it’s a choice about how much time you want to spend and how aggressive you want to be. For many, leaving the driving to others is a good choice.